More On The Casino Known As Aig

March 15, 2009

The Times has two more interesting AIG details today, while we're on the subject. First, I wondered last week if some of the AIG counterparties--that is, the people on the other side of the bets they placed, and to whom a lot of the bailout money is flowing--could be asked to accept a little less. Gretchen Morgenson takes a stab at the answer in her column today:

Why, many people wonder, did the Fed make A.I.G.’s counterparties whole on losses that have not happened yet? Why didn’t it force these financial companies to close out the contracts at a discount, making them take what is known on Wall Street as a “haircut”?

Robert Arvanitis, chief executive of Risk Finance Advisors in Westport, Conn., and an expert in insurance, speculated that the United States was afraid that A.I.G.’s foreign bank counterparties would suffer large hits to their capital cushions, the amount they must set aside in case of losses.

“If somebody takes away the A.I.G. guarantee, all of a sudden the banks’ capital ratios look bad,” he said. “It might have stretched some of these banks.”

Still, Mr. Arvanitis said, it is not clear that the government had to pay out 100 percent of the contracts’ value to all the counterparties. Healthier institutions could have been persuaded to take a haircut, he said. “That is what tough negotiators do,” he added.

Eric Dinallo, the insurance superintendent for New York State, has said that some 80 percent of the estimated $62 trillion in credit default swaps outstanding in 2008 were speculative.

It is unknown how much of the credit default swaps between A.I.G. and its partners were for speculation. That is a question that demands an answer.

Wow. Yeah, that would be nice to know.

--Noam Scheiber

P.S. Just to review, there are two reasons you'd want to buy credit default swaps, which pay you money when a company's bonds lose value: 1.) You own some of that company's bonds and are trying to hedge the risk. 2.) You're simply betting--i.e., speculating--that the company will hit a rough patch. It sounds like Dinallo is saying 80 percent of the swaps were of the latter variety.